Argentina financial services

Argentine central bank cuts policy rate

January 10th 2018 | Argentina | Financial markets and instruments

Event

Following a loosening of inflation targets at the end of 2017, the Banco Central de la República Argentina (BCRA, the central bank) has cut the policy rate from 28.75% to 28%, its first interest-rate cut since November 2016.

Analysis

The unexpected—and somewhat controversial—loosening of the inflation targets for 2018‑20 had given rise to expectations of a rate cut in January. The 75‑basis-point cut was smaller than local expectations, but in line with our view that rate cuts will continue to be gradual. This view rests on two main factors: an attempt by the central bank governor, Federico Sturzenegger, to reassert the BCRA's operational independence following recalibration of targets by the government, and the strong depreciation of the peso that followed the government's announcements on targets, which will complicate the disinflation process.

Immediately after the recalibration of the inflation target, the peso depreciated by 4%, the largest one‑day fall in the peso's value in over a year. In response, inflation expectations for end‑2018 rose to 17.4%, up from 16.6% the month before. The net effect of the target adjustment will therefore be muted as the BCRA is forced to maintain tight monetary policy.

In this context, the government's target adjustment appears to be a strategic error. The government states that the new targets (15% for 2018 and 10% for 2019) are more realistic, and this is true. The government is probably also keen for real rates, which are extremely high, to come down to support the durability of the economic recovery. The government may also have been responding to concerns over real currency appreciation, which has contributed to a large and growing current-account deficit.

However, the perception of discord between the executive and the BCRA will not help to instill confidence in the inflation-targeting framework. In the short term, monetary policy will be complicated further by the latest round of regulated price increases. On January 3rd the government, seeking to reduce the fiscal burden of subsidies, announced an increase of around two-thirds in bus and train fares in the capital, Buenos Aires, between February and June.

Impact on the forecast

There is scope for further rate cuts in 2018. Before the recalibration of the inflation target, we had expected cuts to begin in the second quarter of 2018; although they have started earlier than expected, cuts are unlikely to take the policy rate substantively below our previous expectation, given persistent inflationary pressures.